It's never too soon to start compiling tax deductions

ON THE MONEY

November 11, 2007|By Gail MarksJarvis

This is the time of year when taxpayers pull out the rule book that guides them in making last-minute moves before year-end to reduce their income tax bill.

The summary: Do whatever you can to delay receiving income for the year, and hunt for whatever deductions you can find, so that when you prepare your tax return in a few months, the outcome is as painless as possible.

In essence, you move income - like bonuses or pay you might receive from a business activity - into the new year if you can. And perhaps you pay coming expenses - like January's mortgage payment or property taxes - in 2007 so you can use the deduction this year, rather than next. The strategies are particularly useful to people who think their income is going to be substantially higher in 2007 compared with 2008.

But what do you do when you aren't sure what next year's rule book might say?

That's where taxpayers stand this year. Members of Congress, such as Rep. Charles B. Rangel, a New York Democrat, are proposing a major tax overhaul. So as you plan for the end of 2007 and early 2008, the rule book could end up very different.

In essence, with your year-end tax planning this year, you are aiming at a moving target for next year. Still, Northern Trust tax strategist Grace Allison said: "Don't let uncertainty lead you down the path of inertia."

Although the future remains murky, tax planners are urging the following moves:

Do a quick checkup. Rather than waiting for unpleasant tax surprises when you sit down with your return, pull out a recent pay stub, calculate about what you will earn for the year, and look at how you stand compared with last year, said Rande Spiegelman, vice president of financial planning for Charles Schwab.

There are valuable tax credits you don't want to miss, but they have income limits. For example, the child tax credit - which can lower your tax bill by $1,000 per child - starts to phase out if you are single and your modified adjusted gross income exceeds $75,000, or married with income over $110,000.

A credit for up to $11,390 in adoption expenses diminishes after a couple's income crosses $170,820. Or collecting the maximum Hope and Lifetime Learning Credits for college tuition starts to phase out when income goes over $45,000 for singles or $90,000 for married couples.

Don't waste money. If you set up a flexible spending account at work to pay medical expenses or child-care expenses, make sure you use it up. Depending on your company, you might have to use it by the end of this year, although some plans give you until March 15 to use the money.

Use medical deductions. The threshold for taking advantage of the medical deduction is a difficult one for many taxpayers to meet, especially if your health insurance covers most of your medical costs, says Joseph Karczewski, managing partner at WTAS, a tax and consulting firm.

Your out-of-pocket expenses - or those not covered by insurance or Medicare - are deductible only if they exceed 7.5 percent of your adjusted gross income.

Review your investments. If you have sold investments such as stocks or mutual funds this year and made money, you will owe capital gains taxes on the profit unless the investments are in a tax-deferred account such as an individual retirement account or 401(k).

So look over your investments now and see if you are holding on to any losers you might want to unload. By doing this, you can reduce the capital gains taxes you will owe, or perhaps get rid of them completely.

Timing capital gains with children. If you will be in the 15 percent tax bracket in 2008, and you want to sell an investment with large capital gains, you could have an exceptional opportunity if you delay until January. Then, the 5 percent capital gains rate that applies to relatively low-income taxpayers drops to zero.

But Congress is reviewing capital gains taxes, so this might not last.

Be careful when transferring shares of stock or other investments to children, said Bob Scharin, tax analyst for RIA, a provider of tax information. The kiddie tax laws have changed. So if children under 18 have shares of stock, and sell them, they will pay the same tax as parents.

In 2008, that increases to under 19, or under 24 for full-time college students. That means that if you intend to use stock, mutual funds or other investments to pay for college, you might do well to transfer them to your 18-year-old now, and have him or her sell the shares, Scharin said. The child will probably have to pay only 5 percent on the gain. After this year, the opportunity will disappear.

Before transferring stock to a child, however, make sure the student is not eligible for financial aid. Giving stock, mutual funds or any other investment to a college student, or a student about to go to college, could damage financial aid.